Summary

Move now or wait for hints on possible REIT moves with or without MGP.

By Howard Jay Klein

"The solution often turns out more beautiful than the puzzle…"

Dr. Richard Dawkins, PhD

Few gaming operators have the historical management DNA of Boyd Gaming (NYSE:BYD). It was founded by Sam Boyd, (b.1910-d.1993) an Oklahoma boy who began running bingo games on ships off the California coast and started face to face with casino customers. He came to Las Vegas in 1941, worked as a dealer and eventually, piggy-banked his savings into investments into the old Sahara and other downtown Vegas properties. His son, William Boyd, Jr., later expanded the company into the new gaming markets of the Midwest and south in the 1990s. Eventually, Boyd took a 50% partnership with MGM (NYSE:MGM) in the Atlantic City Borgata, which opened in 2003. It proved one of the savviest moves the company ever made as that property rose to market leadership, a position it holds even today as AC revenues have shrunk to half of what they once were.

Boyd's current CEO Keith E. Smith comes from a banking background and joined the company as Comptroller in 1990, later moving into general management. Eventually, upon Bill Boyd, Jr.'s taking over the board, Smith became CEO in 2008. He is a big-picture guy.

I was at an industry gathering two years ago and its theme was addressing the casino gaming's future. In his presentation, Smith raised the very potent issue of the coming phenomenon of the greatest wealth transfer in the nation's history: namely the $30 trillion boodle that presumably will fall into the hands of Gen X and Gen Y generations when the Baby Boomers and either antecedents, pass on their legacies. With that as a basis, Smith urged as rapid a transformation of the industry as possible to address the leisure proclivities of that demo. And he'd proven the sagacity of that approach long before, when Boyd's Borgata opened in Atlantic City, breaking all the rules of conventional wisdom there and streaking to the top of revenue producers in record time. And now he's moved that perception with the Borgata's online NJ gaming site, which leads all AC competitors in the space.

His was a much broader take on how money will be made in gaming than that of many other speakers that day. And today because of it, it gives me more pause to wonder, why, in its most recent moves, Boyd Gaming has boldly put down its shekels on a place called North Las Vegas. At the moment, at least, it doesn't appear to have the earmarks of a millennial beckoning populace.

Before we tease out whether we see Smith team's moves as supporting a buy, sell or hold on the stock, let's lay out a few pertinent basics on Boyd:

Price at writing: $20.03

52 wk. trading range: $12.88 to $21.43

Market cap: $2.24b

EBITDA: $47,230M

Enterprise value: $5.35b

Ratio: 11.34, sitting just slightly higher than the industry peer midpoint at 51%.

3. A 50% interest in the New Jersey Borgata and complete control of operations, including marketing an online gaming site.

This is a stable, well-managed company that has attracted a lot of recent strong buy sentiment from the street.

"It's a national operator, but Boyd's heart and soul lies in Las Vegas. There's kind of a funny comfort level they have investing there that you don't sense they have anywhere else. Who knows, maybe it's the ghost of old Sam urging them to stay close to home?" said one source.

He is a local wag, a top level Las Vegas industry veteran of many years who currently runs a tribal gaming operation in California. "Locals joints are doing better but for how long?"

The locals move

That appraisal appeared to come true over the past two weeks. Whether management has summoned Sam's ghost through a medium and gotten the memo, or just on the basis of what Smith and his board saw as a realistic take on their vision of a Las Vegas future, we can't say. But one thing is clear: Boyd has decided bet a high stack of chips on its locals gaming profile.

First, it announced it was in late stage talks to acquire Cannery Row Casino Resorts LLC, a privately owned operator of properties in North Las Vegas. The deal is valued at anywhere between $225 million to $240 million. The purchase from Oaktree Capital Management and an Australian partner was made possible after Cannery sold its interests in the Meadow Race Track in suburban Pittsburgh for $440 million. This considerably unwound a complex capital structure that had existed and paved the way for the Boyd deal.

Soon after, Boyd raised its bet again in the Las Vegas locals game when it announced a definitive deal to acquire the Aliante Casino & Spa, also in North Las Vegas, for $380 million - in an all-cash transaction. Management said the buy would be accretive to earnings and cash flow. The 202-room property, originally built for $620 million at the cusp of the 2008 recession, had dived into bankruptcy. Discounted to nearly half its construction price, the Aliante would appear to be a bargain. Our associates there have visited the property and reported that it is snazzy for the area, well maintained and probably requires very little major capex.

Yet it sits tucked miles away from the strip. As do all locals casinos, it will rise or fall based on the depth or shallowness of local patron pockets. There has been some tourist visitation flow there, largely due to people coming to visit local relatives. "It's a really nice place but you have to be a believer," a consulting associate told us.

The question remains why Boyd, with so many opportunities presumably sitting out there across many jurisdictions, chose to pump over $650 million into properties the locals market? And in that space why in North Las Vegas where its properties would sit cheek by jowl with lots of downtrodden housing, near areas with high crime rates and all the urban ills that have gone with that area of Clark County for decades?

Change is a'comin' they say

We may be at the cusp of what Boyd appears to believe is some kind of Las Vegas version of gentrification and industrial expansion in North Las Vegas. Faraday Futures is building a $1 billion auto plant nearby. Boyd says the facility will bring thousands of new, well-paying jobs, retail trade and upscale housing to the area. On top of that, the basic economic barometers of the southern Nevada seem to be pointing north in terms of housing prices, employment statistics, and sustained population growth.

Industry skeptics on the deal have differed. Pointing out that while the Faraday plant and other industrial expansion projects will add a deeper pocketed populace, they believe that those workers won't opt to live or even play at North Las Vegas casino properties: "Those folks will wind up living over in Summerlin or Henderson. They'll choose to commute rather than move into areas near sketchy housing." said another one of our associates.

A local marketing person told me that Boyd properties have a spotty record on generous comps and customer service that runs the entire gamut from very good to terrible. These are impressions that do not materially differ from those of line employees and customers of most competitive Vegas locals places. The best takeaway is this: If you believe the Las Vegas economy is on the upswing and that a form of gentrification can take place spurred by new industry, then these two deals by Boyd can make sense.

But you have to believe in that or else you'd be hard put to make the case for that kind of investment for a company that has already proven its management mettle in tough markets like Atlantic City.

"Why wouldn't they be looking to move on properties elsewhere. Ones with better basic demos. It's kind of like a great jazz musician playing in a local bar," said one former Vegas CEO we spoke to about Boyd. "You have to believe there's an agenda beyond solidifying their position in the locals business. These guys are not dumb."

The South and Midwest

Boyd properties in the central and southern states are performing as decently as can be expected given the stable to sluggish recovery of the gaming industry in general in those jurisdictions. Many of the states in which they operate are fairly saturated, with so-so earnings propulsion going forward. Yet they aren't a drain on resources and produce respectable returns. They could benefit by adding to critical mass there. More on that later in this article.

While we believe Boyd has bought its two new North Las Vegas properties, we don't believe that the sector there is where strong appreciation in the share prices going forward will come from.

Growing consensus among analysts on Boyd trends bullish based on the firmer economic picture seen in its inland segments and belief in its ability to improve performance in its two new North Las Vegas acquisitions.

Right now Boyd is trading near its 52-week high of $21.43. Despite positive sentiment, we don't believe neither its buys in North Las Vegas nor the improving economic picture in the inland jurisdictions into themselves moves the needle for the stock above $22 to $23.

Borgata, MGM and MGP: There lies the rub

Now I'm going to take you through scenarios as a gaming person, ones I've been through myself over many years in top management.

These appraisals always begin with a question: What could they be thinking?

1. An asset compilation before doing a REIT?

I'm not the first observer to see a possible REIT in Boyd's near future. The small New York-based hedge fund Land & Buildings, which first mooted a REIT possibility for MGM, has now weighed in on Boyd as well. In a paper last week, the fund said it believed the strong valuation of MGM's newly public MGP (NYSE:MGP) and Gaming & Leisure Properties (NASDAQ:GLPI) at 14x and 13x projected EBITDA for 2017 could suggest a 60% upside against Boyd's shares at $20.03. This prices an 8x 2017 multiple of projected EBITDA at $36 a share.

Our view: It's possible. The two recent moves in North Las Vegas by Boyd sound a lot to us like it could be portfolio padding at very attractive prices prior to a REIT conversion announcement. As we've pointed out repeatedly, we don't like gaming REITs in principle, but we do sense that management smells low hanging fruit to unlock shareholder value, specifically for the Boyd family holdings.

Our expectation was and continues to be that both GLPI and MGP will shortly come calling on Boyd waving the REIT flag. Of the two possibilities, we clearly see MGP sitting prettier given its existing partnership with Boyd in the AC Borgata. As we've previously written, an MGM/Boyd deal on an MGP acquisition of Boyd's realty makes much more sense to us than either a GLPI move or even one taken independently. When you tally up the time, resources, management diversion, IRS twists and turns, sweat, blood and tears spilled over what could be two years, Boyd would need to expand on their own, the logic of an MGP deal is unshakable on many levels.

The downside on a possible Borgata deal here, of course, is the looming uncertainties in New Jersey occasioned by the irrational action of the legislature to approve a November ballot referendum, which would authorize two new casinos in North Jersey across the river from Manhattan. If it passed and there would be takers aplenty for those two new licenses, Borgata's revenue base in Atlantic City would stand compromised. Not fatal by any means, but clearly at risk. Furthermore, New York State won't sit like a potted plant through such a development. Its Governor and legislature can be expected to act quickly, according to my Albany sources, to amend its new casino laws and accelerate authorization of a casino in the metro area to counter New Jersey's beggar-thy-neighbor move.

Either way, Boyd can't sit fat, dumb, and happy with 50% of its market-leading Borgata property. If it sold its half to MGM, which in turn, dumped it into MGP, Boyd could walk away with a nice management contract and a chunk of MGP shares that would give it participation in future acquisitions of that company.

Conclusion: If you see this possibility materializing in one form or another for Boyd over the next 6 months, we're calling a buy on the stock now. The Land & Buildings valuation is a bit toppy because we think there's a recession risk factor for Las Vegas and inland casinos. Putting that possibility into our calculation, we can feel comfortable with a Boyd upside with some kind of REIT move - its own or with MGP - as moving up or around $28.

2. More portfolio padding with another inland operator.

Isle of Capri Casinos (NASDAQ:ISLE) is now sitting around $14 a share. The fit between Isle and Boyd is excellent. It's easy to see how major corporate and property level cost savings could be achieved by such an acquisition or merger. Moreover, with its 15 properties added to Boyd's 22 (plus its 3 new locals buys), it would strengthen Boyd's inland profile to a far more efficient critical mass, merge its databases and be accretive to earnings from the get-go.

Then in a step two to such a deal, assuming management was still mesmerized by a REIT conversion, it could go solo because its bigger critical mass would make much more sense in terms of the cost, time, and complications of spinning off its realty.

In this case, Boyd is a buy with a price tag we see at $28 to $30 a share easy peasy.

3. If the status quo remains untouched.

Based only on its North Las Vegas moves, its nice but not spectacular outlook inland and its stable though caution flagged presence in Atlantic City, we do not see Boyd as a buy at the moment, disagreeing with much consensus. If you own it, hold it. You will be in good hands insofar as waiting it out until the next shoe drops. If you don't, we see it as a pass at the moment, with better buys elsewhere to be found in the gaming space.

About the author: Howard Jay Klein is a 25-year c-level veteran of the casino industry and a gaming consultant. He is the author of Mastering the Art of Casino Management and the publisher of The House Edge premium site on Seeking Alpha.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.